Delegation: When a win is not a win

How many operations or management functions can a GP delegate to subsidiaries elsewhere before warranting the label “letter box entity”?

Last week UK regulator the Financial Services Authority (FSA) said it would adopt a welcomed “flexible” approach in answering the question. On delegation, the FSA said it would judge UK firms captured by the Alternative Investment Fund Managers (AIFM) directive on a “case by case” basis. A clear victory then for UK GPs who fretted regulators would apply rigid tests to determine when a private equity firm was nothing but a registered mailing address due to too much outsourcing of control.

But will this apparent victory be short-lived? Due to forces outside of its control, the FSA may eventually be required to adopt a different set of criteria on its letter box test.

That’s because pan-EU regulator the European Securities and Markets Authority (ESMA) has final say on how the directive should be interpreted. And EU legislators have reserved the right to review, and instruct regulators to change, how the letter box test is being applied by EU member states in 2015.

Some lawyers predict EU authorities to exercise that right if member states transposing the directive into national law (which must be done by July) adopt varying levels of rigor to the letter box test. “We are seeing evidence already of jurisdictions taking a different approach to the directive’s interpretation, and what might be described as protectionist,” sums up one regulatory lawyer.

Ireland, for example, is attempting to lure fund managers to the emerald isle by taking a relatively lenient view on who gets called a letter box entity. Ireland said its current delegation rules already fit the AIFM bill, and legal sources say Luxembourg is likely to follow suit.

An obvious conclusion here is that sovereigns that take a regulation-lite approach to delegation will be contrasted against those that don’t. And it’s anyone’s guess on whose approach is judged best from the vantage point of EU authorities – who may end up siding with nations that enforce tougher standards on delegation. If so, that may leave GPs bemoaning the EU’s decision to delegate certain rulemaking abilities to individual member states.